Valuation of Energy companies

Valuation experts have developed industry-specific multiples to determine the current value of companies. These techniques demonstrate how much a business is worth. In evaluating the estimate of business worth, a financial ratio such as Enterprise Value (EV) to Reserves, EV to Production, EV to Capacity, EV to Net Income, etc. can be used. Enterprise Value determines a firm’s total value. It takes into account the entire market value rather than considering equity value alone. In so doing, it includes all ownership assets and interests from both equity and debt. EV is an effective cost in purchasing a company or determining the theoretical corporate worth. EV is calculated as:

EV = {Market Capitalization + Market Value of Debt} – Cash and Equivalents

Corporate value is derived from the assets it owns at the time of valuation. However, determining the market value of each asset is difficult and time-consuming. As such, the amount paid for the acquisition of the assets is used. It is worth mentioning that in valuation, the term value defines the current (or market) worth of a company.

EV is composed of equity value, total debt, preferred stock, non-controlling interest, cash and cash equivalents. Equity value can be calculated by multiplying the stock’s current market value and the company’s fully diluted shares outstanding. Total debt component constitutes the creditor(s’) and bank’s contributions. Thirdly, preferred stock consists of a hybrid of securities with debt and equity characteristics. Non-controlling interest is the ownership stake in a subsidiary firm. Lastly, cash and cash equivalents are the liquid assets contained in the company’s financial statement. The last component is lessened from EV since it reduces the acquiring costs of the named company.

EV is used with multiples such as Sales, Production, Capacity, Reserve, EBITDA (earnings before interest, taxes, depreciation and amortization), etc. EV is preferred over other formulae such as Price-to-Earnings (P/E) ratio because EV takes into account debt and cash. This allows identical companies sharing a market cap to have different enterprise value.

Corporate valuation is accomplished by determining the returns achievable in future based on the available key performance indicators (KPIs) during the valuation period – products and services, internal organizational structure, market share, innovative capacity, management, and human resource. Pursuing financial objectives can help derive the corporate value from its capability to generate an extra financial gain for the shareholders.

A combination of several financial ratios can be used to calculate the business’ value for different firms based on the industry in which they operate. For instance, EV/Reserve, EV/Production, and EV/Capacity can be used in combination to determine the corporate market capitalization.

EV/Reserve evaluation approach is suitable for the Energy industry since the companies in this industry are heavily involved in upstream. EV/Reserve indicates the worth of an energy on a per barrel basis. It can be used in conjunction with EV/Production multiple – a measure that depicts corporate value on a barrel per day production basis, and EV/Capacity ratio, which values refiners’ metric on a barrel per day of a refinery. Measures such EV/EBITDA have been used by oil and gas production companies within the Energy industry.

2018-10-14T18:55:48+00:00October 14th, 2018|Financial Intelligence|